Maker (MKR) - FalconX Brokerage Research

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• Later on, we share snippets of these with the public.
• Here are some of our thoughts on Maker ($MKR). If you'd like to learn more about FalconX, request access here.

Executive Summary:

• MKR tokens provide a return to holders in a manner akin to share buybacks.
• Quantity of MKR burned is broadly modelled on three variables: total DAI outstanding, stability fee and liquidation fee.
• ETH locked up in CDPs is a reflection of demand for debt and is limited by  market cap of collateral.
• Assuming the crypto market regains its all time highs, the total market cap for BTC and ETH will be ~$450 billion; @ 1% of market cap, the Dai market will be worth ~4.5 billion.
• If we use a DCF, assuming a constant growth rate (g) of 2%, the market cap of Dai should be ~$2 billion vs. $78 million. Thus, a significant growth in Dai is already embedded in the current market price of MKR requiring a 25x increase in debt issuance.

Background:

MakerDAO is a stablecoin project founded by Rune Christensen in 2014. The project raised $12 million in venture funding from Polychain Capital and Andreesen Horowitz and aims at building a loan portfolio business by combining key characteristics of leading cryptocurrencies, such as censorship resistance and trust minimization, with the relative stability of fiat currencies.

How it Works:

In MakerDAO, the stablecoin Dai is created through a dynamic system that uses Collateralized Debt Positions (CDPs). In a CDP,  a borrower sends ETH to a smart contract, which then returns an amount of Dai based on a collateralization ratio. The full debt + interest denominated in Dai is to be repaid in MKR that is subsequently burned and the collateral is returned to the issuer. In the event the collateral value falls below a predetermined liquidation ratio, the collateral is sold to repay the debt and an additional liquidation penalty is charged (13%).

The project’s MKR token acts as pseudo-equity and as a governance token. MKR holders get rewarded in the form of interest from debts issued on the system and from auto-liquidation fees (payments are not made directly but by burning MKR tokens, which should raise the unit price of MKR). MKR holders have decision-making power over Dai. However, they also assume downside risk. In case an outstanding debt gets auto-liquidated and the system is not able to raise enough Dai to cover the debt, the system dilutes MKR holders and automatically mints new tokens to pay the full outstanding.

Market Size and Potential:

The market potential of MKR is directly linked to the Dai in circulation. Hence, the long term prospects of MKR depend on wide scale adoption of Dai.

On the demand side, Dai serves as a mechanism to:

1. Gain exposure to investment leverage
2. Increase short-term liquidity

However, low leverage potential (Bitmex offers upto 100x), lack of margin calls, and auto-liquidation penalties (13%) render Dai less competitive relative to competition.

On the supply side, Dai scales with the availability of collateral in CDPs. Unfortunately, the crypto world is currently limited in size. As of today, the combined market cap of all digital assets on Coinmarketcap is $121 billion. Even assuming Maker were able to include CDP types for crypto assets that cover 40% of the overall market cap and an average of 6% (1.96% of ETH at present) are locked in CDPs with a 150% collateralization, they’ll have a maximum Dai market cap of $2 billion, roughly Tether’s current use case in crypto markets.

While crypto market caps may grow much larger in the future, the market size of Dai could extend to traditional lending markets as well. Here, debt markets for traditional assets are mature and existing demand for leverage in these markets, including from institutional players, is captured by large financial companies with strong footholds. It is still possible that Maker captures these markets based on its competitive lending rates and if borrowers are willing to understand the platform in enough detail to trust its mechanisms.

In its first year, Maker issued roughly $200 million in loans. 1.96% of all ETH outstanding is locked in MakerDAO with > $70M in loans currently outstanding. MakerDAO is currently collateralized at ~400%, which means for every $1 of loan there’s $4 of collateral backing it up.

Valuation:

There are many methods proposed for token valuation. This is a look at MKR’s value using a discounted cash flow methodology.

MKR tokens provide a return to holders in a manner akin to share buybacks i.e. the MKR tokens get burned after being paid as the stability and liquidation fee. In an attempt to assess the value of MKR burned, we need to estimate the number of Dai created. Since all money locked in CDPs is derived from a natural demand for debt, there is an upper limit to the debt that the market absorbs. For example, if ETH is valued at $150 you can take out up to $100 worth of Dai. However, if the prices increases to $600, you can take out up to $400 of Dai.

As DAI sees greater adoption, the price of the MKR token increases accordingly. Few tokens exist in which adoption of the platform is accretive back to the token holders as a buy-back mechanism.

Assuming the crypto market regains its all time highs, the total market cap for bitcoin and ether will be ~$450 billion. If the debt as a percentage of market cap is 1% (currently  0.5%), the Dai market will be worth ~4.5 billion.

The sensitivity analysis below showcases different market values for Dai given changes in debt as a % of market cap and collateral value.

The value of MKR burned can be modelled as a function of Dai assuming a reasonable stability fee and liquidation fee. While assumptions surrounding this DCF could vary significantly, we have provided a summary table to understand the current value of MKR in greater detail.

The current market cap of MKR @ ~$523 million implies a price to earnings ratio of 1331x (assuming current stability fee is sole revenue stream; outstanding Dai is revolved once a year and current fee rate is constant). Assuming a constant growth rate (g) of 2%, the market cap of Dai should be ~$2 billion vs. $78 million. Thus, a significant growth in Dai is already embedded in the current market price of MKR requiring a 25x increase in debt issuance.

This, however, does not present a compelling investment opportunity. An investment in MKR is a bet on:

1. The crypto universe rebounding beyond prior all-time highs
2. Real world assets getting tokenized and used to borrow in the MakerDAO

Authors: Anish Parvateneni and Robin Lobo

The information provided in FalconX documents and accompanying material is for informational purposes only.  It should not be considered legal or financial advice.  You should consult with an attorney or other professional to determine what may be best for your individual needs. FalconX does not make any guarantee or other promise as to any results that may be obtained from using our content. No one should make any investment decision without first consulting his or her own financial advisor and conducting his or her own research and due diligence. To the maximum extent permitted by law, FalconX disclaims any and all liability in the event any information, commentary, analysis, opinions, advice and/or recommendations prove to be inaccurate, incomplete or unreliable, or result in any investment or other losses. Content contained on or made available through this material is not intended to and does not constitute legal advice or investment advice and no attorney-client relationship is formed. Your use of this information is at your own risk.

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